4 Essential Business Overdraft Tips for Small Business Owners
Small businesses can access a wide range of tools that help them manage their finances. Personal loans, small business loans, lines of credit, merchant cash advances, invoice factoring, etc. are great tools when used correctly. Compared to these tools, corporate overdraft facilities seem outdated.
However, there is a lot to be said for a simple overdraft. They are easy to obtain and help your business overcome short-term cash flow problems. Although easy to obtain, they are difficult to manage because overdrafting your account can become a costly habit.
Overdraft advice for small businesses
Here are 4 things to keep in mind about overdraft facilities for small businesses.
When used correctly, an overdraft facility will help you tremendously. The key to using overdrafts correctly is to forecast cash flows in advance and plan for cash shortfalls. For example, is your business prone to seasonal cash shortages? You can use an overdraft to help pay salaries and other running costs of your business.
It’s also a good idea to keep an overdraft as a backup option for tough times. Test your cash flow projections to see if you might need to tap into the overdraft facility. Remember that overdrafts are subject to interest.
Formal overdrafts are negotiated in advance with the bank and have lower interest rates than informal overdrafts. An informal overdraft occurs when you overdraw your account. The unplanned nature of the latter attracts higher interest rates. Consider these costs before deciding to withdraw excess liquidity from the facility.
It’s also a good idea to be proactive about your overdraft facility. If you find the limit is too low after a stress test of your finances, ask to extend it. You don’t want to run out of money when times are tough.
Use overdrafts to close great deals
Small businesses need all the market advantage they can get. Once in a while, a great opportunity presents itself, but companies are not in the right cash position to take advantage of it. An overdraft can help tremendously in such situations.
For example, if one of your suppliers offers a large discount on a large amount of inventory, you should buy as much as possible. However, cash limits your purchasing ability. In this situation, if the extra profit you make by buying goods at a low price outweighs the interest you will pay on the overdraft facility, using overdraft is a smart business decision.
Some small business owners avoid overdrafts because of high interest rates. However, they can be useful and help you get some great deals. Don’t forget to factor in any overdraft fees. Along with interest, you’ll also pay one-time setup fees, referral fees, and potential additional interest if you go over your overdraft limit.
Overdrafts are also useful when your customers are taking longer than expected to repay you. In businesses where credit cycles are standard, overdrafts offer as much value as invoice factoring and prepayment discounts. Be sure to tell your customers to pay you electronically instead of paper checks.
Electronic methods allow you to deposit money into your account faster and you will always have up-to-date financial information.
Use it only for short term goals
Some business owners fall in love with their overdraft facilities. The result is that they use their overdraft for all kinds of financing. This is a very bad decision since higher interest rates accumulate over time and erode any benefits that the flexibility of an overdraft brings.
Overdrafts are best used to fill short-term cash holes. More importantly, you need to know for sure that your cash hole will be filled quickly. For example, if you’re looking to pay off existing debt using an overdraft, that’s a bad choice.
Overdrafts are best suited to help you overcome short-term cash flow holes such as seasonal revenue dips or late customer payments. Either way, you can rest assured that cash flow will pick up. In these cases, the higher interest rates make a minimal dent in your business expenses. This will not be the case in the long term.
Digital-only banks these days offer a range of services to their customers at cheaper rates than traditional banks. It’s no different with overdraft facilities. Be sure to shop around if you plan to use an overdraft facility.
Although interest rates on an overdraft should not be the main point of evaluation for an account, you should pay attention to it. Lower fees and simpler approval processes can give your business an edge when cash flow is low.
Less used options
Overdrafts don’t get much attention or use when it comes to financing options for small businesses. However, they are an excellent choice when used correctly. In the short term, they give your business an edge and increase profits. Be sure to use them to overcome short-term cash flow problems and not long-term business problems.